Introduction

The share price maximizing rule has fostered an attitude of indifference to zero-NPV projects which creates a propensity to under invest. Assuming that the product market is highly efficient and perfectly competitive then, in that case, the company’s assets and management will be expected to earn only the normal rate of return. Hence, the managers cannot be expected to maximize the share price in order to achieve abnormal gains. In this paper, we have discussed about the Net Present Value (NPV) method which is the optimal investment selection criteria for any company. Secondly, the paper discusses about the wrong assumption of maximizing share price which companies make as a condition of investment in any projects which leads to an underinvestment bias. The paper highlights the main objective of selecting investment proposals for the company in the competitive market which is based on conventional theory.

Share Price Maximization as prime objective- Myth

Investors cannot expect to have windfall gains by holding a portfolio of shares of a wealth maximization company. For example, in share market, shareholders expect to gain abnormal returns in form of wealth accretions, but there is an assumption which states that in an efficient market, shares cannot expect to receive abnormal returns. In the real world, investor believe to gain more by investing in a better managed company, but in a well managed company the price of shares will be already discounted as will the inferior earning power in the inefficient managed company. In this view, J. Ignacio Pena(1995) has argued that the cost of information prevents the market from being perfect informational efficient which in my opinion is true to some extent as its not possible for an investor to have correct information at the correct time. But, the disparity lays in the fact that in spite of errors in the market due to costly information, it can result to an over or under valuation of future earning potential of the firm. Graham Quick(1995 suggested that even in the perfect market the investors can foresee the firm’s expectation for roughly two years which in his opinion implies that the share price cannot be discounted for all future asset growth. In my opinion, with Graham Quick’s idea we can presume that all growth companies are undervalued and declining companies are over valued due to the fact that the share price of those companies are not been discounted for more than two years.

Christopher R. Smallwood(1995) ideas reflects that the market runs on risks and uncertainty and therefore the market cannot make accurate expectations during the floatation of the company about its wealth generation capacity for the whole life but its possible to expect for succeeding short periods. Altogether he believes that the Share Price Maximization must be the prime objective of the firm. This makes us believe that the product market is so imperfect that that the firm can afford to make abnormal returns as a pre condition of investment which certainly cannot be agreed because even if the market is uncompetitive then at least the securities market should be able to expect the firms position to earn abnormal return in the future which can result in eliminating the future expectation of growth in the share price.  In this point of view, Graham Quick(1995) has given preference of investing in shares in order to secure abnormal returns as he says it’s superior to alternatives together with the level of risk involved. In my opinion, his thoughts can be concluded by saying that the investors are not willing to accept the minimum rate of return in spite of the fact that they cannot expect better than the equilibrium return.

We can explain this issue by an example, where a company X is having a well managed team and their share price reflects their performance and excellence in their work. In this case if the company performs better as expected then the growth in the share price will be a normal growth and not abnormal. Therefore, if the company doesn’t achieve abnormal gain then it’s not due to the under performance of it but due to the efficiency of the market in anticipating their performance in the initial share price. Whereas in another company Y, which has an ordinary management team, their performance is reflected in their share price. If the company performs better than expected then their share price will see a rise. This implies that there has been an abnormal share price growth in company Y but it could not be said that company Y management has performed better than company X. It shows that such a growth in the share price prove to be have an inability to predict the future than the skill of the managers.

Therefore it can be concluded that the expectation of growth on an average gets eliminated for the best of companies. Share price maximization should not be the prime objective of the management while making an investment decision. In my view, share price normally doesn’t reflect the performance of the firm as the price gets effected due to inflation and retained earnings. It can be said that the share price is not a good indicator to measure the management’s performance.